Risk Management in the Shipping Industry Essay Example

Risk Management in the Shipping Industry Essay Example Risk Management in the Shipping Industry Essay Risk Management in the Shipping Industry Essay Risk Management in the Shipping Industry Shipping is a business that is extremely in tune with prevailing market sentiment. Its success depends on a prospering economy, due to the increased global trade. It is also partially sheltered from temporary downturns because businesses will switch from more expensive air freight, and save costs by using shipping as their means of transporting their goods instead. The industry is also an extremely competitive one, as there are only two main considerations why businesses will prefer one shipping company over another the price and speed at which their goods are delivered to their destination. This has made it difficult for companies to differentiate themselves and demand a higher premium for their services. As a highly volatile business, shippers are subjected to three main types of risk: freight price risk, fuel price risk and interest rate risk. 1) Freight price risk Freight rates have historically been very volatile, and this has made it difficult to accurately predict the cash inflows of the company. This is due to the impact of unforeseen geo-political influences and the slow speed of adjusting supply to demand. Freight price risk is thus the risk of loss arising from unexpected changes in freight rates. As a result, shippers commonly buy and sell futures contracts called freight forward agreements based on the Baltic Dry Index of bulk rates to hedge against the risk that a rise or fall in the spot rate might cut into the profit they expect from the voyage. 2) Fuel price risk Fuel prices take up a large amount of variable costs and companies try to hedge against any upward spikes. Although, it is possible to pass on these fuel surcharges to the customers, there is a limit to any increases in order for the firm to continue offering competitive pricing. Call options are often used as the solution and bought at a certain fuel strike price, to hedge against a rise in the future. If the actual price rises above the strike price, the company will choose to exercise the option to buy the fuel at the lower strike price, thereby putting a limit to their cash outflows. 3) Interest rate risk Shipping is a capital intensive industry with significant funding needs for fleet expansion and replacement purposes. Yet, it has very little opportunities to diversify its sources of funding, because most of it comes from bank debt. Some loans are at fixed interest rates, while others are at floating rates. The company thus strives to maintain the optimum mix of fixed and floating interest rates on its net debt that best reflects expectations and risks by engaging in interest rate swaps. In conclusion, the issues of variability and uncertainty in the future will always continue to plague businesses. While risk management can do very little to influence variability (markets will continue to fluctuate no matter how advanced risk management techniques become), much can be done to hedge against the uncertainty.